In the UK, a partnership is one of the most common ways to runs a business. With several hundred partnerships currently in operation across the country, you probably want to know why. So, what are the benefits of starting a partnership?
Benefits of working as a partnership
Working as a partnership has a number of benefits, the first one being that it is less formal and there are fewer legal obligations. The accounting process is also generally simpler than it is for limited companies. This is because partnership business do not need to complete a Corporation Tax Return (although they do still need to keep a record of expenses and incomes).
Partnerships are easy to get running off the ground because this can be done either verbally or in writing. There isn’t the need to register with Companies House and registering the business with the HMRC is straightforward. Each partner also has to register individually for self assessment which can be done online.
Of course, more brains means more ideas which is great in business. Opting to run your business as a partnership also means that you have additional access to knowledge, skills, contacts and experience – not to mention that you get to share the burden of the work load.
There is also often, more control in a partnership business. This is because limited companies have a shareholders and directors (although these can sometimes be the same person). But, it can mean that constraints are put in place by the shareholder. A partnership works different in that both partners own and control the business so, as long as both parties agree with the business decisions, there aren’t any constraints.
So, partnerships look very appealing and you might think it is the right decision for you moving forward with your business but, it is important to consider both sides of the argument when making your decision.
Set back of being in a partnership
Often partnerships find it difficult to raise funds that can be compared to limited companies. This is because banks tend to favour the transparency and separate legal responsibilities that are not tied to an individual – for this reason, banks may be unwilling to lend you what you need or set strict terms. With this, it is important to consider what your business will be and, the amount of funds that need to be raised.
Just as two heads are better than one, working in a partnership can lead to conflict. If there are disagreements about how to manage the business, the accounts and future plans, it can increase the pressure and end up consuming lots of time, money and energy.
Profits are automatically shared in a partnership. Under the Partnerships Act 1980, profits are shared equally, unless amended by a partnership agreement. This can put strain on a business relationship because if one party feels their skills are more important or, that their partner isn’t investing as much time, tension can build up.
Now you have seen both pros and cons for starting a partnership, it is important to explain how profits are calculated.
How are profits calculated in a partnership?
In a business partnership, profits can be shared in any way you wish, so long as both parties are in agreement about the profit-sharing. If the profit share is 50/50, neither party can make a decision about the other’s approval. If that split is 51/49 however, the majority profit holder has final authority. For this reason, it is important to have everything in writing in a partnership agreement.
Things to consider including in your partnership agreement should include:
- Division of profits
- Contributions to the partnership
- Who does what
- Business decision-making
Working with a lawyer and accountant on this means that you avoid costly mistakes further down the line.
To calculate the profits in your partnership, you need to start with the net profit that your partnership has made that year (net profit is the difference between the revenue and expenses).
From here, each partner must declare a share of this figure on their individual tax returns. This is because the partnership itself does not owe taxes but, the person. The net profit also helps to judge the business performance and can be used to determine return on investment.
What profits do HMRC tax?
The HMRC determine how much to tax in the same way as a sole trader which is based on profits and losses. The partnership is entitled to claim deductions from the business income for anything that is required to ensure the business can run.
Partners must ensure all of the expenses that they wish to claim for are included in the profit and loss account, there is no option to deduct these from the share of profits after allocation between the partners.
For example, if any partner runs an office from home or has a mobile phone, they need to be accounted for through the profits of the business for them to benefit from tax relief.
We hope this has helped you understand more about partnerships and how profits are determined. If you are considering starting a new partnership or are already in a partnership and would like some advice, please don’t hesitate to get in touch with the Cooper Accounting team, we would be more than happy to help.